But how the Bush administration and Congress respond to the root cause of these happenings will define the Fed’s outlook. If they get it wrong, Americans are headed for a sustained bout with stagflation. If they get it right, the U.S. could enjoy another period of economic expansion.

Since 2005, U.S. imports have exceeded exports by more than $700 billion. The principal causes for this imbalance are oil imports, lopsided trade with China and other Asian developing countries, and our reliance on Japan and Korea for affordable automobiles. To finance the trade gap, Americans sell bonds and other securities to foreigners, and until recently Wall Street banks, like
Citigroup
and
Merrill Lynch
, recycled those funds to American consumers.

The consequences of this grand deleveraging are compounded by festering longer-term global problems. Rising gas prices divert what money Americans still have to spend to oil-rich nations, further draining demand for U.S. goods.

Global oil supply is not keeping step with demand, because several important exporters, including Venezuela, Russia, Nigeria and Mexico, have shunned the investment and know how Western oil companies can offer to sustain their production.

As the dollar plummeted against the euro by some 80% since May 2001, governments in China and elsewhere maintain weak currencies by buying dollars on foreign exchange markets. This subsidizes their exports to the U.S. and Europe, stokes steroidal Asian growth and artificially boosts Asian oil consumption. Significantly, China and others use some of those dollars to subsidize fuel prices, further exacerbating international oil shortages.

The housing bubble and credit meltdown created more unwitting victims than greedy malefactors. Federal efforts to route capable but currently distressed homeowners into sustainable mortgages, the tax-rebate stimulus package and even the Federal Reserve’s generous lending to the more culpable New York banks will help avoid economic Armageddon. However, achieving a sustainable economic expansion requires strong new disciplines, from loan officers on the ground to the executive suites at those New York banks, as well as real initiatives to cut U.S. oil imports and help Americans better compete internationally.

Higher oil prices are here to stay, but the technologies to reduce U.S. oil imports dramatically are at hand. Hybrids, plug-in electric and even hydrogen-powered vehicles are longer fanciful proposals. Coal gasification is viable at $55 dollars a barrel for oil, and more efficient building designs, appliances and heating systems are all possible at affordable costs.

Economists assert the market will provide, but they fail to reckon with the fact that most epic transformations in transportation technology–canals, turnpikes and national highways, railroads and airplanes–got boosts from the government to overcome the barriers created by habits and switching costs. For example, the biggest problem getting into hydrogen cars will be the initial investment in fueling stations and quickly achieving a critical mass of vehicles on the road to sustain them.

Japan, Korea, India and China have promoted their domestic vehicle industry by limiting imports and exploiting the open U.S. market, and now Japan, the most mature producer, boasts
Toyota
and
Honda
as the leaders in hybrids and greener vehicles.

The U.S. should not turn to protectionism, but rather, it should use its large market to its advantage. It should require much higher mileage standards for automobiles, and offer substantial product development assistance to U.S.-based automakers and suppliers–that includes Toyota and Honda, as well as the Detroit Three, battery makers and other suppliers–to accelerate the buildout of high-mileage innovative cars.

The condition for assistance would be that beneficiaries do their R&D and first large production runs in the U.S., and share their patents at reasonable cost with one another. The huge U.S. market would attract producers from around the world and rejuvenate the U.S. auto supply chain.

Similarly, accelerating clean coal gasification, nuclear power and the hydrogen transformation, as well as mandating much more efficient buildings and home heating systems and appliances, would propagate exciting new technologies Americans could sell around the world.

These innovations are going to happen. Will Americans do the innovating or end up buying other countries’ cars and energy-saving technologies, trading oil dependence for technology servitude?

Ending the huge trade deficit and ruinous foreign borrowing will require more. It is essential to secure fairer terms of competition abroad for U.S. businesses and workers through tangible steps, which would in turn counter Chinese and other Asian currency manipulation and change trade agreements that open U.S. markets to foreign products but not foreign markets to U.S. products. Regarding the latter, U.S. exporters of cars and other durable goods face tariffs in excess of 25% in China, India, Brazil and elsewhere, while U.S. duties are less than one-fifth those levels. U.S. firms must often establish production and research facilities abroad to get protection for their intellectual property.

Neither the Clinton nor Bush administrations have adequately addressed these issues. The likely nominees, Sens. John McCain and Barack Obama, so far seem more inclined to generalize about markets and green jobs than propose substantive policies to wean Americans from the oil addiction, fire up innovation and get U.S. products fair terms in global markets.

Sustainable prosperity requires it.

Peter Morici is a professor at the University of Maryland School of Business and former chief economist at the U.S. International Trade Commission.